Macroprudential and Monetary Policy Dilemmas in a · PDF fileMacroprudential and Monetary...

Macroprudential and Monetary Policy Dilemmas in a

Small Open Economy

Júlia Király and Attila Csajbók

MNB

Lecture in the National Bank of Serbia

Belgrade

May 31, 2012

Motivation: Why Hungarian monetary policy had to be

procyclical during the crisis?

4

6

8

10

12

-8

-6

-4

-2

0

2

4

Jan-0

8

Apr-

08

Jul-

08

Oct-

08

Jan-0

9

Apr-

09

Jul-

09

Oct-

09

Jan-1

0

Apr-

10

Jul-

10

Oct-

10

Jan-1

1

Apr-

11

Jul-

11

Oct-

11

percentpercent

GDP-growth (seasonally adjusted data, yearly changes)

Base rate (right-hand scale)

2

• The monetary policy framework in Hungary

• Macroprudential policy

• FX-lending: magnitude and key drivers

• Monetary policy in the presence of FX-lending

• Implications for institution design

Overview

3

• IT since 2001 (with wide ER bands until 2008, free float afterwards)

• Open economy: Exports+Imports~200% of GDP (Poland: 20-30%)

• Trade oriented towards EU: 75%, of which 55% Eurozone

Exchange rate channel strong

• Financial intermediation: deepening, but still lower than in Eurozone + a large part FX-denominated

Interest rate channel weaker

: Strong reliance on the ER channel

The monetary policy framework

4

5

IT was successful in bringing down inflation…

0

5

10

15

20

25

30

35

Jan/93

Jul/

93

Jan/94

Jul/

94

Jan/95

Jul/

95

Jan/96

Jul/

96

Jan/97

Jul/

97

Jan/98

Jul/

98

Jan/99

Jul/

99

Jan/00

Jul/

00

Jan/01

Jul/

01

Jan/02

Jul/

02

Jan/03

Jul/

03

Jan/04

Jul/

04

Jan/05

Jul/

05

Jan/06

Jul/

06

Jan/07

Jul/

07

Jan/08

Jul/

08

Jan/09

Jul/

09

Jan/10

Jul/

10

Jan/11

Average inflation before IT:17.8

Average inflation after introducing IT: 5.4 %

6

…but not in stabilizing inflation around the MNB’s target(s)

2

3

4

5

6

7

8

9

10

11

2

3

4

5

6

7

8

9

10

11

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

% %

Consumer

price index

Year-end

targets

Medium term

inflation

7

Exchange rate band inconsistent with IT

150

170

190

210

230

250

270

290

310

330

350

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

HU

F/E

UR

Volatile risk premium: 5-year CDS-spread

0

100

200

300

400

500

600

700

800

Jan-0

8

Mar-

08

Jun-0

8

Sep-0

8

Dec-0

8

Mar-

09

Jun-0

9

Sep-0

9

Dec-0

9

Mar-

10

Jun-1

0

Sep-1

0

Dec-1

0

Mar-

11

Jun-1

1

Sep-1

1

Dec-1

1

Mar-

12

basispoints

8

9

Volatile CDS spread – due to high vulnerability

0

10

20

30

40

50

60

70

80

-20 -10 0 10 20 30 40 50 60

Net external debt/GDP(%)

Gross public debt/GDP(%)

HU

LV

ET

LT

PL

BL, RO

SK

SL

CZ

Volatile risk premium + „fear of floating”?

0

3

6

9

12

15

80

100

120

140percentJan 2008=100

HUF/EUR exchange rate (Jan 2008=100) MNB base rate (right-hand scale)

10

• The monetary policy framework in Hungary

• Macroprudential policy framework

• FX-lending: magnitude and key drivers

• Monetary policy in the presence of FX-lending

• Implications for institution design

Overview

11

12

Types of policies aiming at financial stability

• Crisis management

• Crisis containment: handling an acute liquidity crisis, preventing creditors/depositors run

• LOLR (central bank)

• Enhancing deposit insurance (fiscal authority)

• Crisis resolution: overcoming a solvency crisis

• Portfolio cleaning, recapitalisation, closing (fiscal authority)

• Crisis prevention (prudential policies)

• Microprudential: aimed individual institutions (supervisory authority)

• Macroprudential: aiming financial stability (post-crisis an increasing role for central banks) (cross border effects)

13

Macroprudential institutional framework in Hungary

Pre-crisis

• Tri-partite system (Financial Stability Committee):

• Hungarian Financial Stability Authority (HFSA): microprudential supervision

• Central bank: macroprudential monitoring – but no policy tools

• Ministry of Finance: regulatory power

• No clear mandate for macroprudential regulation and supervision

• No proper alignment of responsibilities and tools

• Example: MNB sent regular warnings (both to the FSC and publicly) about the risks of FX lending, but this was not followed by policy action by MinFin or HFSA

• The monetary policy framework in Hungary

• Macroprudential policy

• FX-lending: magnitude and key drivers

• Monetary policy in the presence of FX-lending

• Implications for institution design

Overview

14

Household savings proved to be low – with compared with the

high government debt

BE

BG

CZ DK

DE

EE

IE

GR

ES

FR

IT

CY

LV

LT

HU

MTNL

AT

PL

PT

ROSI

SKFISE

UK

y = 0,4706x + 19,759R² = 0,1761

0

20

40

60

80

100

120

140

160

0 50 100 150

Bru

ttó á

llam

adóss

ág (a G

DP a

rányában)

Egy főre jutó GDP (EU átlaga=100; 2010)

BE

BG

CZDK

DE

EE

IE

GR

ES

FR

IT

CY

LV

LT

LU

HU

NLAT

PL

PT

RO

SISK

FI SE

UK

NOHR

y = 0,3235x + 26,048R² = 0,3337

0

20

40

60

80

100

120

140

160

0

20

40

60

80

100

120

140

160

0 40 80 120 160 200

A háztartások nettó pénzügyi vagyona (a GDP

arányában; 2009)

Source: Eurostat

Per capita GDP Household net wealth / GDP

G

o

v

e

r

n

m

e

n

t

d

e

b

t

/

G

D

P

FX lending – reasons and consequences

BANKS

• Liquidity awash

• Cheap funding and cheap swaps –

lack of long term local funds

• Risk based competition („Ninja-

loans”

Cím: Minta Cím - Előadó: Minta Előadó 16

HOUSEHOLDS

• Classical dollarization

• Short planning horizon - optimism

• Gambling motive

0

10

20

30

40

50

60

70

80

90

100

Estonia Latvia Lithuania Bulgaria Romania Poland Hungary Czech

Republic

Slovakia

%

0

1

2

4

5

6

7

8

10

11

12

Ratio of FX loans (2005) Ratio of FX loans (2008) Interest rate differential

Currency board

All in all: lack of effective macroprudential regulation

0

10

20

30

40

50

60

702002.I

.

II.

III.

IV.

2003.I

.

II.

III.

IV.

2004.I

.

II.

III.

IV.

2005.I

.

II.

III.

IV.

2006.I

.

II.

III.

IV.

2007.I

.

II.

III.

IV.

2008.I

.

II.

III.

IV.

2009.I

.

%

0

10

20

30

40

50

60

70%

Banking sector Corporate sector

General government Net external debt

Net external debt – a kind of private credit boom

(the 12-percent debt service to the GDP rate was not too high, relatively (1995: 33%))

Stylised facts on (unhedged) FX lending

0

4

8

12

16

20

24

28

32

2000Q

1

Q3

2001Q

1

Q3

2002Q

1

Q3

2003Q

1

Q3

2004Q

1

Q3

2005Q

1

Q3

2006Q

1

Q3

2007Q

1

Q3

2008Q

1

Q3

2009Q

1

Q3

2010Q

1

Q3

2011Q

1

Q3

in proportion to GDP (%)

HUF loans CHF-based loans EUR-based loans Other FX-based loans

18

FX lending – and the background

Global financial system –

foreign owned banking sector

'Fiscal alcoholism'

High rate of inflation

HIGH PUBLIC DEBT

FX lendinglending

Boom in residential lending

HIG

H E

XT

ER

NA

L D

EBT

High HUF interest rates

150% loan to deposit

ratio (L/D)

20

Why widespread FX lending is a systemic risk? Part 1: Solvency

• Banks do not have an open FX position (microprudentially may look OK), but…

• …households’ exchange rate risk can easily transform into credit risk of banks…

• … higher credit risk of the financial system gets reflected in sovereign spreads

(contingent claim on the state)

• increases funding cost for banks due to (1) their sovereign exposure or (2)

internal pricing of funds in cross-border banks (Note that this happens regardless

of their individual portfolio quality! systemic contagion )

• reinforces solvency risk (vicious circle)

The downside of borrowing in a ‘safe haven’ currency

80

100

120

140

160

180Jan 2008=100

HUF/CHF exchange rate (Jan 2008=100) HUF/EUR exchange rate (Jan 2008=100)

21

Non-performing loan ratios (NPLs) on mortgages

0

2

4

6

8

10

12

14

16

0

2

4

6

8

10

12

14

16

2008Q

1

Q2

Q3

Q4

2009Q

1

Q2

Q3

Q4

2010Q

1

Q2

Q3

Q4

2011Q

1

Q2

Q3

Q4

percentpercent

Mortgage loans - FX Mortgage loans - HUF

22

23

Why widespread FX lending is a systemic risk?

• Long-term mortgage credits were financed mainly by

• short-term foreign funding (L/D problem, maturity mismatch) or

• domestic deposits + FX swaps

• A freeze of the FX swap market can cause serious liquidity problems

• Just like a sudden depreciation, as FX swap contracts involve daily margin call

requirements

• The central bank’s LoLR capacity in FX is limited (by reserve size)

• International cooperation of central banks (swap lines) may help

• However, this help is by no means automatic or immediate

Why widespread FX lending is a systemic risk? Part 2: Liquidity

0

50

100

150

200

250

300

350

Dánia

Letto

.

Svédo.

Észto.

Íro.

Litvánia

Ola

szo

.

Fin

no

.

Magyaro

.

Portugália

Szlovénia

Fran

cia

o.

Ho

llan

dia

Sp

an

yo

lo.

Ausztria

Románia

Cip

rus

Németo.

Bulgária

Len

gyelo

.

Görögo.

Belg

ium

Szlovákia

Málta

Cseh

o.

Luxem

burg

%

High loan/deposit ratio = high external funding ratio

0

10

20

30

40

50

60

70

80

Málta

Lettország

Cip

rus

Írország

Litvánia

Luxem

burg

Románia

Magyarország

Belg

ium

Ho

llan

dia

Észtország

Portugália

Görögország

Bulgária

Finnország

Dánia

Szlovákia

Franciaország

Svédország

Lengyelország

Ausztria

Csehország

Németország

Spanyolország

Szlovénia

Olaszország

%

The other source of funding FX lending: domestic deposits +

swaps

0

2

4

6

8

10

12

14

16

18

20Jan-0

7

Apr-

07

Jul-

07

Oct-

07

Jan-0

8

Apr-

08

Jul-

08

Oct-

08

Jan-0

9

Apr-

09

Jul-

09

Oct-

09

Jan-1

0

Apr-

10

Jul-

10

Oct-

10

Jan-1

1

Apr-

11

Jul-

11

Oct-

11

Jan-1

2

Apr-

12

billion EUR

Net FX swap stock of the banking system

25

Recurrent turbulences in FX swap markets…

-50

0

50

100

150

200

250

300

350

400Jan-0

8

Mar-

08

May-0

8

Jul-

08

Sep-0

8

Nov-0

8

Jan-0

9

Mar-

09

May-0

9

Jul-

09

Sep-0

9

Nov-0

9

Jan-1

0

Mar-

10

May-1

0

Jul-

10

Sep-1

0

Nov-1

0

Jan-1

1

Mar-

11

May-1

1

Jul-

11

Sep-1

1

Nov-1

1

Jan-1

2

Mar-

12

basis points

3-month FX-swap implied yield spreads

26

…and the use of MNB FX liquidity providing instruments

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

Oct-

08

Nov-0

8D

ec-0

8Jan-0

9Feb-0

9M

ar-

09

Apr-

09

May-0

9Jun-0

9Jul-

09

Aug-0

9Sep-0

9O

ct-

09

Nov-0

9D

ec-0

9Jan-1

0Feb-1

0M

ar-

10

Apr-

10

May-1

0Jun-1

0Jul-

10

Aug-1

0Sep-1

0O

ct-

10

Nov-1

0D

ec-1

0Jan-1

1Feb-1

1M

ar-

11

Apr-

11

May-1

1Jun-1

1Jul-

11

Aug-1

1Sep-1

1O

ct-

11

Nov-1

1D

ec-1

1Jan-1

2Feb-1

2M

ar-

12

million EURmillion EUR

One-day FX swap facility 6-month FX-swap facility 3-month FX-swap facility

27

• EBCI, ESRB etc. (too late – nothing to do with the accumulated stock):

• Country specific approach is requested

• Home and host country policies should be coordinated

• Long term local currency capital markets should be developed

• Level playing field should be taken into consideration

• Bans on fx lending may become counterproductive

• Adequate liquidity buffers should be provided

• Hungary

• MNB initiated „responsible lending” regulation (LTV caps, lower for FX) in 2009,

became effective at the beginning of 2010

• New government imposed an outright ban on FX mortgages in August 2010

• These measures were absolutely necessary to increase systemic resilience but

the timing of their application (at the beginning of recovery) was procyclical

• Stock problem is not yet solved (recent government measures proved to be

counterproductive)

28

FX lemding: lessons from the crisis „learnt”

29

New mortgage lending of Hungarian banks

FX loans virtually disappeared from new lending, …

0

20

40

60

80

100

0

40

80

120

160

200

Jan-0

7

Apr-

07

Jul-

07

Oct-

07

Jan-0

8

Apr-

08

Jul-

08

Oct-

08

Jan-0

9

Apr-

09

Jul-

09

Oct-

09

Jan-1

0

Apr-

10

Jul-

10

Oct-

10

Jan-1

1

Apr-

11

Jul-

11

Oct-

11

Jan-1

2

%HUF bn

HUF FX Proportion of HUF denominated contracts (right-hand scale)

30

… but the stock is here to stay for a while

0

500

1 000

1 500

2 000

2 500

3 000

3 500

4 000

4 500

2012Q

1

Q2

Q3

Q4

2013Q

1

Q2

Q3

Q4

2014Q

1

Q2

Q3

Q4

2015Q

1

Q2

Q3

Q4

2016Q

1

Q2

Q3

Q4

billion Ft

Household FX loan stock - projection

• The monetary policy framework in Hungary

• Macroprudential policy

• FX-lending: magnitude and key drivers

• Monetary policy in the presence of FX-lending

• Implications for institution design

Overview

31

• Widespread unhedged FX lending constitues a systemic risk…

• …thus imposing a serious financial stability constraint on a monetary policy that normally operates through the ER channel, as…

• …a depreciation increases both solvency and liquidity risk in the banking sector

• In a dowturn, the room for monetary easing may become very limited

Main lesson 1: the constraints on monetary policy

32

Integrating macroprudential policy in the central bank

operational framework

1 4 3

2

Price stability goal Financial stability goal

Monetary policy tools Macroprudential tools

Macro stability goal

: primary use of tool : secondary use of tool OR ‘unintended consequence’

33

• Interaction between monetary and macroprudential policy – mechanisms are complex, currently far from well-understood

• Because of the FX debt constraint, interaction is very important and explicit in the Hungarian case

• In day-to-day policymaking, need for a ‘modus operandi’: this involves some shortcuts

• Monetary policy decision-making formally takes into account financial stability „constraints”

• Perceived financial stability risk appears in the monetary policy reaction function of the MPM - model

• Interest rate reaction to risk premium shocks depends on whether the economy is perceived to be in ‘normal mode’ (low δ) or ‘crisis mode’ (high δ)

• A systemic stress indicator (among other info) is used to decide which regime we are in

Financial stability/monetary policy interaction in the MNB’s

practice

34

Systemic financial stress indicator

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,70

0,80

0,90

1,00

Systemic stress indicator Critical threshold

35

• Beside contemporaneous indicator, need for more strategic assessment (how far currently we are from the stability constraint?)

• One analytical tool for this is the credit risk stress test (normally includes a substantial ER shock), sometimes in reverse stress test form („death zone estimations”)

• Regular financial stability chapter in the material for monthly rate-setting meetings + analysis of effects of macroprudential measures, if necessary

• Macroprudential policy takes into account monetary policy in some respects: e.g. in stress testing: the design of stress scenario, typical mon. pol. reaction to GDP or risk premium shock

Interaction of monetary and macroprudential policymaking in

the MNB

36

• The monetary policy framework in Hungary

• Macroprudential policy

• FX-lending: magnitude and key drivers

• Monetary policy in the presence of FX-lending

• Implications for institution design

Overview

37

• Failure of the tri-partite system in Hungary to stop the dynamic increase of unhedged FX lending

• Microprudential regulation in itself is insufficient

• Macroprudential responsibility should be explicitly stated

• It should be clearly allocated among the stakeholders (central bank, FSA, MinFin)

• In any institutional setting, the central bank has to play a key role in macroprudential policymaking

• Macroprudential tools have to be allocated where the responsibility lies

• Cross-border macroprudential coordination is important (multilateral: ESRB, bilateral: home-host)

Main lesson 2: institution design

38

Recent change of Central Bank Act:

• delegates explicit macroprudential responsibility and regulatory tools to the MNB in the areas of:

• Countercyclical buffer

• SIFI capital regulation

• Curbing excessive lending

• Containing systemic liquidity risk

Recent developments in the institutional framework

39

• Achieving price stability is necessary but not enough to achieve

economic stability: financial stability should be considered by central

banks

• Financial sector is not frictionless: procyclical behavior with

nonlinearities (credit crunch, sudden stop, overheating, fx lending…)

• Better understanding of „contagion”

• Inflation target is rather short run – macroprudential target is for

medium/long term

• Macroprudential and monetary policy may have conflicts by

construction

• A good institutional framework is of great value

Lessons from the crisis: macroprudential policy is required